The sub categories don't seem to be working correctly on my site.
for example I have a top level category called Cables, then 3 sub categories called ethernet, power, and test
I have images uploaded for the sub categories and it shows them when you edit the sub category yet on the right pane display it says "Picture for category Ethernet"
Update to this post since the site structure has changed. The sub categories still don't display the images or even if you don't add an image to a sub category it doesn't display that default "No image available" thumb.
Looks like you are using the ProductsInLines1 template for your top level categories. Change these to ProductsInGrid and you should see the images for sub categories.
If you want to stick with the productsinlines template then just have a look at how sub category images are created in the ProductsInGrid template and add the necessary code.